In some parts of the world, the financial advisory industry is under attack. Britain and Australia have taken steps to eliminate commissions as a form of advisor remuneration. Because the vast majority of Canadian financial advisors are paid by product commissions, many advisors fear that Canada will follow suit.
But I believe that we are unlikely to go down that road in the foreseeable future. Here’s why:
> The GST Experience. The 1991 introduction of the GST effectively unbundled the previously embedded 13.5% manufacturers’ sales tax. Canadians didn’t react well to this because price tags did not jibe with the final tally at the checkout counter. In other words, Canadians seemingly prefer the out-of-sight, out-of-mind structure of taxes built into a single price.
Similarly, Canadian investors are often reluctant to pay fees explicitly, preferring to have them bundled and hidden. Granted, the financial services industry shares some blame for this. I recall that my sales training as a new advi-sor included an explanation of deferred sales charge commissions that went something like: “Clients don’t have to pay you directly … the fund company pays out an amount equal to a small percentage of the investment, etc.”
Nonetheless, when I’ve explained compensation to clients over the years, most people give the proverbial thumbs-up. But explaining how large a cheque a fee-only client must write evokes a very different reaction.
> Canada Favours Disclosure. Similar to my experience in dealing with clients, Canadian regulators seems to prefer disclosure over the practice of banning commissions. Almost a year ago, a new registration rule came into force. The rule originated years ago as the fair-dealing model. The FDM had proposed exactly the kind of changes that Britain and Australia have embraced.
The FDM had sought to clarify the allocation of responsibilities, make all dealings with retail inves-tors transparent and deal with conflicts of interest. That last item refers to the conflict of interest that results when advisors are compensated directly by product sponsors (in the form of commissions) rather than by their clients.
The FDM had proposed three possible approaches to dealing with this conflict, one of which was effectively to ban all “third-party” payments to advisors (i.e., commissions). It is a massive understatement to say that industry stakeholders were opposed to this.
Fund companies then proposed disclosure to clients that would allow them to make informed decisions. And the regulators folded, opting for watered-down disclosure and backing away from any commissions ban. The new registration rule is less than a year old, so another major overhaul seems unlikely for many years.
> Market Forces Are At Work. I contend that competitive market forces will continue pushing the industry toward unbundled, fee-only compensation. Fee-only arrangements have seen modest momentum over the past decade, perhaps because of the challenges noted above. But the fee-only model’s rising popularity will accomplish two things.
First, it will make clients more aware of this less common way to pay for advice. Second, those who continue to be compensated by commissions may be forced to disclose more clearly, in writing, the fees and compensation associated with investment recommendations.
Feedback from advisors indicates that the fee-only model is likely to catch on in larger cities but not in smaller towns. Plus, a commission ban is likely to leave clients with portfolios smaller than $250,000 with inferior, or no, advice.
My advice to advisors fearing this trend is to offer a range of compensation structures and to work with your compliance department to write a one-page disclosure of fees and compensation. Such disclosure is likely to be the first your client will see and it will communicate confidence in your “value-added.” IE
Dan Hallett, CFA, CFP, is director, asset management, for Oakville, Ont.-based HighView Financial Group, which designs portfolios for advisors, affluent families and institutions.